What alimony tax issues apply when paying or receiving alimony? After all, divorce can be difficult enough. Add to it that divorced individuals may have to pay or receive alimony just complicates issue. If this is your situation, here are some tips for how to correctly treat the payments on your tax return.
Definition of Alimony
The first thing to consider is the definition of alimony. There are actually two definitions. The first is payments made under divorce decrees and separation agreements established before 1985. The second is for agreements made since that time. For the purposes of this article, only the rules for post-1984 decrees and agreements will be mentioned in this article.
Alimony: Post-1984 Decrees and Agreements
For decrees and agreements made after December 31, 1984, here are the following requirements when facing alimony tax issues:
- The payments must be paid in cash to a spouse, ex-spouse or third party. They must be on behalf of a spouse or ex-spouse.
- The payments must be made after the divorce decree is final. What if payments are made under a separation agreement? Again, the payments must be made after the agreement is final.
- The payments must be required. This can be by a decree or instrument incident to divorce, a written separation agreement, or a support decree.
- The payments cannot be assigned as child support. Child support payments are not income for the recipient. They are also not a deduction for the payer.
- The payments made while spouses or ex-spouses share the same household don’t qualify as alimony. This is true even if the spouses live separately within a dwelling unit.
- The payments must end upon the death of the payee. You would think that would be common knowledge, but hey, I thought I should point it out anyway.
- The payments can’t be subject to the status of a child. This is to prevent child support from being hidden as alimony. The IRS will catch this if you try to deduct it.
Exception to the Definition of Alimony
So, you have established that payments you receive from a spouse or former spouse meet the definition of alimony. Take note, those payments are taxable for the person who receives them. Let’s look at the flip side of the matter. What about payments made to a spouse or former spouse that meet the definition of alimony? Those payments are tax deductible for the payer. There is one catch to this rule. The divorce decree must point out that alimony payments are not deductible or taxable. The same is true for the separation agreement.
Additional Alimony Tax Issue to Consider
What does the IRS require for the taxpayer who deducts alimony? You must include the payee’s Social Security Number (SSN) on the tax return. That means you and your spouse may want to end things on a good note. Why? The person who receives the payment must provide their Social Security Number to the payer. If the divorce is not friendly, this could be a touchy subject.
The IRS pointed out that a many taxpayers report their alimony correctly. This happens when the person who receives the alimony does not report the full income. On the flip side, this happens when the person paying the alimony claims they paid more than they really did. The IRS has a way to compare the amounts listed on the payer’s and recipient’s tax returns. This will flag an IRS agent just wringing their hands, waiting to do an audit. But first, the IRS will send a written request for additional information. This is known as a correspondence audit. If you can prove it, great! If not, get ready to fork over some money to correct the issue.
What does alimony have to do with an IRA?
The person who receives the alimony payments may treat the payments as compensation. This is true even if the payments are that person’s only income. So here is some good news. This allows the person who receives the alimony to save for their retirement. You can take some of the money and contribute it to a Traditional or Roth IRA. This is because the rules require the contributor to have earned income or compensation. There you go! Alimony income is included as this requirement.
What if my divorce requires both alimony and child support?
What happens if the divorce decree, the other written instrument, or an agreement calls for both alimony and child support? The person making the payments pays less than the total required. This is because the payments apply to child support first. Any amount that is left over is then considered alimony income.
There is no income tax withheld from alimony payments. The recipient may need to consider making estimated tax payments. This will prevent any tax surprises at tax time next year.
Other Alimony Tax Issues
As if these alimony tax issues weren’t enough. Other issues can come up to complicate things. Those are not addressed here. Do you have questions about your situation? Maybe you’d like to discuss alimony as it applies to you? Why not give Alex Franch, BS EA a call at 781.849.7200? Alex is an enrolled agent with the IRS. He has the knowledge to help you work through the complex issues regarding alimony.